The privatization payoff.
A phenomenon is sweeping across the world stage that is unique in the annals of business. Its financial and geopolitical impact will be worldwide. Through it, technology will improve the economies of nations and the lives of ordinary citizens. And participating investors and politicians might alter the course of history.
This process is the large-scale privatization of government-owned industries. Virtually overnight, countries and their governments in every region of the world have repudiated socialistic, "managed" economies and have embraced private investment and free enterprise. As a result, the business and investment communities now are confronted with an unprecedented opportunity and challenge.
Among major industries being privatized are electric services, telecommunications, petroleum exploration and development, railways, steel production, and mining--each a critical part of the infrastructure needed to build or sustain economic success. I will focus on electric power production and distribution, one of Houston Industries' key businesses. But my comments, particularly those on risk analysis, are pertinent to any industrial privatization.
Through privatization, poor countries are finding it possible to leapfrog decades ahead in building infrastructure required for development. Newly industrializing nations are using privatization as a means to speed the spread of prosperity among their citizens, bolstering lagging economies or adding momentum to those that are taking off. Even highly industrialized countries are getting into the act to enhance their positions in an increasingly competitive and ever-more-open world marketplace.
In many countries, state-owned enterprises such as electric utilities have been big money losers, requiring massive subsidies. Being extremely capital-intensive, they often have burdened governments with crushing debt. And, in many cases, the inability of governments to finance needed expansion has hampered industrialization. In India, for example, an official with the U.S. Agency for International Development estimates that inadequate and reliable electric supply costs industry 1.5 percent of GNP; in Pakistan the figure could be 1.8 percent. In other cases, frequent blackouts or brownouts have undermined political support and the credibility of the government.
For some nations, the sale of utility and other assets also offers a way out of an international debt problem. By privatizing, the government not only attracts investment and operating expertise, it raises hard currency that is used to reduce international debt. In turn, this may reduce pressures from the International Monetary Fund, the World Bank, and private lenders, and facilitate loans needed for other purposes.
Finally, in an increasing number of nations, the decision is being made to let business handle what it does best, while the government focuses on areas such as defense, public health, and education, where it is the logical large-scale provider.
WANTED: CAPITAL TRANSFUSIONS
The scope of the investment needed is staggering. There are at least 50 major nations in the process of privatizing, ranging from Argentina to Australia, Bangladesh to Brazil, Italy to India, Peru to Pakistan, Turkey to Thailand, Mexico to Malaysia, and China to Colombia.
In the electric supply sector, the U.S. Agency for International Development estimates that developing nations' demand for electric power is increasing at an annual rate of 6.5 percent. In the U.S., the Edison Electric Institute forecasts a more modest annual rise of only 1.9 percent over the next decade.
According to AID, the electricity requirements of developing and industrializing nations over the decade will amount to whopping $100 billion a year, "...sums which are not now and are unlikely to be available in the future from developing nation's treasuries."
These figures only address known, new additions to the existing power supply. Add to this the expected value of government-owned generating, transmission, and distribution system assets where these are being sold. This process has just begun, but to date these asset sales have raised about $140 billion of private investment. CS First Boston estimates that additional sales of existing government-owned electric facilities in the next decade could exceed $500 billion.
In Latin America, according to the Latin American Energy Organization, "...there is a $13 billion a year investment deficit in the electricity sector which has forced some countries to ration power and threaten(s) economic growth." As shown in Exhibit II, in some South American countries, the consumption of electricity per capita has more than doubled in the past 20 years. In some, it is forecast to more than double again in the next seven to eight years. This is fairly typical: Electric consumption usually matches or exceeds growth in GDP until a country reaches a level of development typical in the U.S. or Western Europe.
Latin American countries have undertaken a major effort to attract private investment. Several already are successfully privatizing, and Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Peru, and Venezuela all have adopted legislation geared to attract foreign investment.
Asia faces similar problems with electricity supply. According to the World Bank, if Asia is to sustain the average 8.4 percent growth rate it realized in the 1980s, generating capacity will need to double by 1999. This alone would require the equivalent of $450 billion. China, India, the Philippines, Indonesia, Thailand, Malaysia, and others are struggling with economies that are being restrained by electric supply shortages.
Add these ingredients to the recipe, and the full scope of private investment needed just for electric system privatization over the next decade approaches $1.5 trillion. Such an outlay is analogous to a modern day, private sector Marshall Plan.
WHERE'S THE PUSH?
These opportunities represent the "pull" luring investors. But why would chief executives consider leaving the safety of the U.S. or Western Europe business environment for less familiar territories abroad--the "push" factor in the economic equation?
Many companies like my own face a maturing market in existing operations. Our forecast for our subsidiary, Houston Lighting & Power, for example, parallels the national electric demand forecast--approximately 2 percent growth compounded over the next decade. That contrasts with as much as 13.8 percent in some years, during decades when sales at our utility could more than triple.
If we're to achieve the earnings growth needed to sustain attractive dividends and total return for our investors, we have little choice but to explore new markets with our other subsidiaries.
Other companies in the electric sector are coming to the same conclusion. At least 12 other U.S. electric utility affiliates currently are bidding on privatization projects. Utilities in Spain, France, Chile, and Belgium also have entered the market. And independent power producers in the U.S., which have built about half the new generation here for the past several years, are starting to move into the privatization arena, as slower domestic growth and competition have consistently whittled away their returns.
ENTERING THE MARKET
For many companies, mature markets and the size of new privatization opportunities abroad will provide ample initial attraction. However, a more detailed analysis will be required to identify particularly appealing market niches and to see if a firm has strengths that can provide a competitive advantage. Methods of privatization can affect this analysis.
* Share distribution. Some governments have chosen to distribute shares on the stock exchange. This model has been used extensively in Europe and is being adopted in some Asian markets. It is probably appropriate if a business--or the broader industry of which it is a part--is reasonably well-run and efficient, and if there is a viable stock exchange to serve as a vehicle for trading.
* Asset sales. This method involves either the outright sale of assets, or the sale of a controlling interest in them, to an investor, along with a concession or franchise. This is probably most appropriate where improvements to the operation are needed. This approach is the one most typical in Latin American markets.
* Market liberalization. In some countries, the government is partially privatizing by retaining existing assets but opening the market to new private suppliers to meet expanding needs.
Analysis of our strengths convinced us that our 110-year experience in designing, building, and operating large utility facilities would allow us to enhance existing utility operations where they are being privatized. We could add value and realize efficiencies through a hands-on approach. Ownership of a controlling interest ourselves, or as part of a consortium in which we would be involved in operations, became one targeted approach.
Our second thrust is in the area of new power additions. And we're taking a different approach than most competitors.
Governments that are privatizing often call for and receive bids from scores of potential generating firms when new plants are needed. There's often little to differentiate these bidders.
Rather than respond to every request for proposals for a power station, our focus is to build on existing expertise with familiar industries. Our utility subsidiary has long served some of the largest facilities in the petrochemical, refining, oil services, transportation, and biomedical industries. We not only understand their power requirements, but their internal plant processes. Just as important, they know us and our capabilities; we're a proven quantity. We tell these firms we'll build and operate dedicated power facilities, on their plant sites if appropriate, anywhere in the world they wish to locate or expand their facilities. This offers advantages in cost, reliability, and scheduling, even in areas where power supply is inadequate or unreliable.
By selecting these two approaches, we've both differentiated ourselves by focusing on our strengths and expertise, and effectively narrowed the market niches in which we wish to compete.
Having completed a competitive analysis, we proceeded to a series of risk analyses.
Any investment involves risks, but offshore investments--particularly those in countries in the early stages of privatization--involve additional concerns.
Obviously, country risk is a prime consideration. By this I mean the overall stability of a given nation. Established governments that enjoy popular support and facilitate free enterprise are likely to attract capital. On the flip side, investors probably won't beat down the doors of nations where terrorism, armed opposition factions, and coups are the norm. Unfortunately, some nations continue to face these difficulties, and the returns for investors in these situations will have to be very high for them to tolerate the risk.
For us, highly volatile political situations are unappealing. Others may have more tolerance for such risks.
Other considerations include national trade and foreign investment policies. Is there a provision for repatriating profits from an investment? And if you buy a company that needs upgrading, will you be able to import equipment without encountering monstrous tariffs? Will the government permit the renegotiation of union or supply contracts? Is inflation in the country under control? If free enterprise policies are relatively new in that locale, does the government (and the population) have a long-term commitment to them?
Culture and economic history also may affect a company's decision. In some former socialist states, for example, companies aren't familiar with the basic principles of Western accounting and finance. In some instances, AID has enlisted American firms to show countries interested in privatizing how to install generally accepted accounting, budgeting, and audit systems, so that an acceptable book value can be established for assets to be privatized. This was the case when Houston Industries worked with AID to assist a utility in the Czech Republic. (The utility has since been privatized through share distributions.)
TAKING THE PLUNGE
Houston Industries' initial privatization investment was in the electric distribution system in La Plata, Argentina, a city of 700,000 that is the capital of the Buenos Aires province. We're part of a consortium of two U.S. and two Argentine firms that bought majority ownership of this system. A review of why this investment was attractive to us may be a useful example of risk analysis for privatization.
We were attracted to an investment in Argentina, because, among other reasons, the government is stable, and legislation provides protection for private property and enterprise.
Initially, we completed a technical analysis on several properties the government offered for bids. Some of these we rejected out of hand because we didn't feel the risk-adjusted returns would be adequate, or because they would have required the infusion of too much additional capital.
However, we were attracted to three distribution systems. Besides the La Plata system--also known as Edelap--there were two distribution systems in Buenos Aires called Edenor and Edesur. In addition to clearing our hurdle rates, the bid packages for these properties offered investor safeguards, including a management contract that effectively provided a revenue floor; an allowance for renegotiating union and other existing contracts; and provisions for protection against currency fluctuations and for the repatriation of profits.
Also important: We were able to link up with large, well-respected Argentine firms--Techint Compania Tecnica Internacional and Los W S.A.--as well with Citicorp S.A. We knew these companies could provide legal expertise and intelligence on the Argentine culture and politics. Their contribution to analyzing service area economies and local demand forecasting was invaluable.
Although unsuccessful on bids for Edenor and Edesur, our consortium was the winning bidder for La Plata's Edelap. The bid price was $138 million for a 51 percent ownership (39 percent of the system was retained by the government, and 10 percent was given to employees). The range of bids on all these properties was surprisingly broad, perhaps because they reflected widely different bidding strategies and return requirements. There was a spread of about $250 million between the winning and low bids on both Edenor and Edesur; the spread on the smaller Edelap system was about $90 million.
In any acquisition, you receive some surprises. And ours was no exception. We expected "non-technical" losses--including power diversion or theft--in the neighborhood of 16 percent of generation. The actual figure was somewhat closer to 21 percent.
We also have been subject to greater natural gas fuel curtailment in the winter than we anticipated because of inadequate pipeline capacity. That means slightly lower revenue from the power station that was part of our purchase.
In addition, damage from severe storms in a system with predominantly overhead power lines is worse than we expected. In some cases, to make post-storm repairs, we've tied two trucks together to create four-wheel drives. In Argentina, four-wheel trucks are scarce.
Nonetheless, the La Plata investment is performing. The equipment is proving to be sound, employees are technically competent, we substantially reduced non-technical losses, an early retirement program has helped alleviate overstaffing, and the reliability of service to customers in La Plata is improving steadily. At the bottom line, the system is reporting profits.
WINDOW OF OPPORTUNITY
The scale of privatization represents an unprecedented investment opportunity. Yet the window of opportunity is relatively small. In what will probably be only a decade, governments worldwide will attempt to privatize and modernize a staggering array of industrial enterprises.
The U.S. government, under the auspices of AID and other agencies, is doing what it can to expedite and encourage the process, because it embraces privatization as a means to stabilize the global economy and to demonstrate the viability of free enterprise.
Done successfully, privatization will play a key role not only in improving the quality of life of millions, but also in ushering in an era of international cooperation and coexistence as we move into the 21st century.
Don D. Jordan is chairman and chief executive of TX-based Houston Industries, a $4.6 billion diversified holding company. Its Houston Lighting & Power subsidiary is the eighth largest U.S. electric utility, and its KBLCOM cable TV subsidiary is among the 15 largest in the country. Its Houston Industries Energy subsidiary is involved in the Argentine system mentioned in this article and is pursuing other non-regulated utility operations in the U.S. and abroad.
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|Author:||Jordan, Don D.|
|Publication:||Chief Executive (U.S.)|
|Date:||Nov 1, 1993|
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